a16z: After securities are on the blockchain, why will intermediary institutions be replaced by code?

Original Title: A Former SEC Chief Economist Analyzed How Tokenized Securities Can Benefit From DeFi

Original Authors: @milesjennings, @rstwalker and Aiden Slavin, a16z crypto

Translation by: Peggy, BlockBeats

Editor's Note: As regulators begin to actively promote "traditional securities on-chain," the question is no longer whether the technology is feasible, but whether the system is ready to keep up.

This article revolves around a key proposal: in the context of the U.S. Securities and Exchange Commission (SEC) promoting on-chain financial markets, a16z and the DeFi Education Fund proposed a "software safe harbor" framework, attempting to delineate regulatory boundaries for a new class of market participants—non-custodial, decentralized blockchain applications.

The core logic is not complicated: if these applications are merely neutral software interfaces that do not control assets, execute trades, or provide advice, should they still be included in the regulatory framework of traditional brokerages?

Former SEC Chief Economist Craig Lewis's analysis provides a more structured answer to this question. He does not start from "whether there should be regulation," but rather returns to a more fundamental comparison: given the existing high costs and opacity of the brokerage system, does the introduction of on-chain trading and automated settlement weaken the market or reconstruct its operating methods?

On one hand, atomic settlement, on-chain transparency, and 24/7 trading are redefining the efficiency boundaries of financial infrastructure; on the other hand, investor protection mechanisms, market fragmentation, and new types of risks are also emerging simultaneously. The real divergence is not whether these risks exist, but whether they have already existed in another form within the traditional system, only long ignored.

From this perspective, the "safe harbor proposal" resembles a kind of institutional experiment: it attempts to open a limited but verifiable space for on-chain finance without completely overturning the existing regulatory framework. The key question thus shifts from "should we go on-chain" to "which aspects can go on-chain first."

If the past decade's crypto industry has approached traditional finance on a technical level, the next real variable may come from how regulation redefines the boundaries of the role of "intermediaries."

The following is the original text:

Bringing traditional securities on-chain is one of the core priorities of the current U.S. Securities and Exchange Commission (SEC). The Commission recognizes the potential of tokenization and, under the leadership of Chair Atkins, launched "Project Crypto" nine months ago, aiming to update the rules and regulatory framework related to U.S. securities. Its goal is to gradually migrate the national financial market to on-chain, thereby achieving a series of advantages such as instant settlement, 24/7 trading, and cost reduction.

However, to truly unleash the full potential of tokenized securities, innovators and investors still need clear "game rules," especially for blockchain applications that allow users to trade tokenized securities in a peer-to-peer manner without intermediaries.

Based on this, we submitted a "software safe harbor" proposal to the SEC in August last year in collaboration with the DeFi Education Fund, clearly defining under what conditions these blockchain-based applications—acting as neutral software that enables users to interact with public chain networks and smart contract protocols—can be exempt from the registration requirements of the Securities Exchange Act of 1934. This proposal not only elaborates on how these applications create value for market participants but also explains how they align with the SEC's core mission in protecting investors, maintaining market fairness and order, and promoting capital formation.

Today, Craig Lewis, a professor at Vanderbilt University, former SEC Chief Economist, and Director of the Division of Economic and Risk Analysis, has formally submitted his economic analysis report on the "software safe harbor" proposal to the SEC. Although Lewis's research focuses on the proposal itself, it more broadly assesses the economic costs and benefits of tokenized securities, providing important insights into how blockchain technology can reshape the traditional financial system. Although this research received funding support from a16z, Professor Lewis employed an independent and rigorous methodology during the evaluation process.

In his analysis, Lewis identified five major benefits that the safe harbor mechanism could release for compliant applications:

• Atomic Settlement: Eliminating counterparty credit risk from delayed settlements and reducing systemic risk that may arise from central counterparty failures.

• On-chain Transparency: Replacing opaque private ledger systems with publicly verifiable transaction records.

• 24/7 Continuous Trading: Breaking through the time and geographical limitations of traditional exchanges, enhancing price discovery efficiency and liquidity.

• Substantial Cost Reduction: Automatically executing dividend distributions, compliance processes, etc., through smart contracts. For example, research by Ripple and BCG shows that tokenizing investment-grade bonds can reduce operational costs by 40% to 60%.

• Lower Barriers to Entry: Attracting new developers into the market, creating competitive pressure on traditional financial institutions, driving their innovation, and ultimately benefiting users.

At the same time, Lewis also pointed out four types of potential costs that the proposal might bring:

• Investor Protection May Be Weakened: For example, traditional brokerages can freeze assets or roll back transactions, while compliant applications are not designed to have this capability.

• Regulatory Arbitrage Risk: Some traditional institutions may attempt to transform into compliant applications to evade regulatory obligations, but the transformation costs may be high.

• Market Fragmentation Risk: Tokenized securities trading may further disperse market liquidity and transmit risks to the traditional financial system through DeFi leverage mechanisms. However, Lewis believes this should be assessed in comparison to the existing dark pools and over-the-counter trading systems.

• Retail Trading Cost Issues: Risks such as gas fee fluctuations, slippage, and smart contract vulnerabilities, but these should be compared with the implicit costs in traditional finance. Meanwhile, DeFi fees are significantly decreasing; for example, Ethereum's Dencun upgrade has reduced L2 data costs by over 90%.

Lewis's analysis specifically limits itself to front-end applications that meet safe harbor conditions and emphasizes that these applications are essentially "passive software interfaces" designed not to introduce the risks that the Securities Exchange Act seeks to avoid. These conditions include:

• Non-custodial architecture

• No autonomous trading execution rights

• No marketing or investment advice

• Only connecting to truly decentralized (or striving in that direction) protocols

He further points out that the benchmark for comparison should not be some idealized market structure but the current brokerage system—which contains many hidden costs, such as DTC fees, clearing and settlement fees, intermediary markups, and insurance buffers.

Ultimately, Lewis concludes that if the SEC formally assesses these costs and benefits, it is likely to find that the safe harbor mechanism helps to release the significant economic value inherent in tokenized securities.

As Chair Atkins stated, tokenization "has the potential to reshape the financial system as we know it." The SEC has expressed support for this direction through "Project Crypto," joint guidance documents, and other means.

However, to truly realize this vision, a clear and effective regulatory framework still needs to be established for blockchain applications that support peer-to-peer trading. This is precisely the goal of the safe harbor proposal, and Professor Lewis's analysis also indicates that its overall economic logic is compelling—despite the trade-offs, the benefits are likely to outweigh the costs.

Lewis has already charted the path, and we look forward to the Commission advancing along this route.